November 30, 2011

Would Extending Unemployment Benefits Increase Unemployment?

John Boehner and Mitch McConnell have announced they will join Democrats in pushing for an extension of payroll tax relief, in some shape or form. Less certain is whether Republicans go along with an extension of unemployment insurance (UI), much of which will expire in January 2012. If they do wind up opposing the extension of UI, don’t be surprised: GOP partisans have long argued that providing benefits to the unemployed creates a “moral hazard” by reducing their incentive to work, or even look for work.

What’s the evidence for this point of view? The best known argument comes from Harvard economist Robert Barro. In an article for the Wall Street Journal that appeared in August 2010, Barro estimated that if the Obama administration had not extended maximum unemployment insurance to 99 weeks (rather than the standard 26 weeks), the unemployment rate at that time would have been close to seven, not 9.5, percent. In other words, Barro was suggesting, a lack of incentive to work, rather than a lack of incentive to hire, was the reason for high unemployment. The Obama administration had become its own worst enemy.

But Barro’s opinion is an outlier. Berkeley economist Jesse Rothstein, in a September study, argues that while the extension of UI indeed increased the unemployment rate by about 0.3 percent, the “vast majority” of unemployment was due to “demand shocks” not “UI-induced supply reductions.” Or, to put it a bit more crudely, people are unemployed because they can’t find jobs – not because UI keeps them from looking too hard (see graph below).

The Congressional Budget Office, in a November report, adds that even if UI benefits convince some people to stay out of work, those job openings quickly get filled by new entrants into the labor market. Perhaps the most definitive rebuttal of the Barro argument comes from a March study, from scholars at the The New School. Surveying empirical literature on UI’s effect on employment, the researchers make a couple of important points. First, they find that UI claimants did not find themselves out of work longer than other jobless workers who likely didn’t have unemployment benefits. Second, the researchers discovered, unemployed workers do not search for work more or reduce their wage expectations once their benefits run out.

And then there’s the question of how UI stimulates the economy. As the November CBO report estimated, extending unemployment benefits would result in 0.4 to 1.5 dollars of GDP growth in 2012 for every dollar it costs the government. Providing employees with payroll tax relief, by contrast, would grow the economy 0.1 to 0.6 dollars per dollar spent. Ezra Klein, via Howard Gleckman of the Tax Policy Center, explains one reason this might be the case: payroll tax relief boosts saving, while unemployment insurance is more likely to boost spending. Whatever the explanation: More growth means more jobs.

None of this means Republicans will come around on UI, the same way they’re coming around on the payroll tax break. But their arguments against UI seem just as weak as the ones against the payroll tax were.